- Read and summarize chapter 26 of your Financial Management text book in at least 400 words.
-Explain the concept of “reducing funding costs.”
- How important is credit when trying to obtain financing?
- Please complete questions #9,#10 and #12 of the chapter.
An alternative to the issuance of a corporate bond, a corporation
can issue a security backed by loans or receivables. Securities that
have as their collateral loans or receivables are referred to as asset-
backed securities. The transaction in which asset-backed securities are
created is referred to as a structured finance transaction or structured
financing. In this chapter, we will explain what is meant by a structured
finance transaction, the reasons why a corporation would use a struc-
tured finance transaction rather than issue a corporate bond, and how
rating agencies assess the credit risk of a structured finance transaction.
While our focus in this chapter is on structured financing used by corpo-
rations, it should be noted that some municipal governments use this
form of financing rather than issuing municipal bonds and several Euro-
pean central governments use this form for financing.
WHAT IS A STRUCTURED FINANCE TRANSACTION?
The term “structured finance” refers to a wide variety of debt and
related securities. The key element of structured financing is that the
obligation of the issuer to repay lenders is backed by the value of a
financial asset or credit support provided by a third party to the transac-
tion.1 When we say the value of a “financial asset” we mean a loan, an
account receivable, or a note receivable. Keep in mind that a loan or a
1 Andrew A. Silver, “Rating Structured Securities,” Chapter 5 in Issuer Perspectives
on Securitization (New Hope, PA: Frank J. Fabozzi Associates, 1998), p. 5
A
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862 SELECTED TOPICS IN FINANCIAL MANAGEMENT
receivable is a financial asset to the lender but a liability to the bor-
rower. So, in a structured financing, the lender is using a pool of loans
or receivables as collateral for debt instruments that it issues. To obtain
a desired credit rating sought by a corporation for the asset-backed
securities created by using a structured financing, both the value of the
financial assets and a third-party credit support may be needed.
In Chapter 15 where we discuss intermediate- and long-term debt
instruments, we described secured debt instruments whose credit stand-
ing is supported by a lien on specific assets (i.e., a mortgage bond or col-
lateral trust bond) or by a third-party guarantee. However, with
traditional secured bonds, it is the ability of the issuer to generate suffi-
cient earnings to repay the debt obligation that is necessary for the issuer
to repay the debt. So, for example, if a manufacturer of farm equipment
issues a mortgage bond in which the bondholders have a first mortgage
lien on one of its plants, the ability of the manufacturer to generate cash
flow from all of its operations is required to pay off the bondholders.
- Why should the investor in an asset-backed security be concerned
with the capability of the servicer - What are the obligations that must be paid by the issuer of an asset-
backed security? - Why doesn’t an issuer of an asset-backed security seek the highest
credit rating of triple A?